Final answer:
Firms use advertising to differentiate their products from competitors, which can make their demand curve more inelastic or increase demand, ultimately aiming to boost profits. They can also increase demand through product differentiation and by building a strong reputation to gain customer loyalty.
Step-by-step explanation:
Firms use advertising for many reasons, but typical objectives are to stimulate demand, to stabilize sales, and to inform, remind, and reinforce customers. Advertising is integral in communicating to consumers that the products of one firm are differentiated from those of another firm, particularly in a framework of monopolistic competition.
There are two principal effects of advertising in this context: it can either make a firm's perceived demand curve more inelastic, meaning the demand curve becomes steeper, or it can increase the demand for a firm's product, causing the demand curve to shift to the right. Either scenario can lead to a firm selling a greater quantity or charging a higher price, boosting overall profits.
Apart from advertising, firms can also engage in product differentiation, which is any action taken to make consumers believe their products are distinct from their competitors'. This might involve improving quality, employing innovation, or enhancing customer service to build a strong reputation and thus, potentially command higher prices.
A strong reputation is critical as it leads to repeat customers who may recommend the business to others, thereby ensuring a degree of customer loyalty and potentially justifying premium pricing.